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Friday, April 06, 2007
P-Notes will go when economy opens up
The issue of money from stock markets being used for terrorist activities is being hugely exaggerated, says M Damodaran, chairman, Securities and Exchange Board of India (Sebi). In an exclusive interview with ET, Mr Damodaran said that the know-your-client norms being enforced by various regulators were effective in checking money laundering and round tripping of tax evaded money through stock exchanges. Here are some excerpts from the interview.
Private equity interest in the Indian market is on the rise. Globally, questions have been raised about the manner in which PE funds act at times. Is Sebi planning to regulate PE funds in India?
Private equity investors have become very important for the Indian market. The fact is, today we do not regulate private equity participants. We need to understand what increased private equity interest means for different markets. Clearly, there are positives. We have seen private equity investors get into small companies, build them into large companies and bring in better practices, better understanding of markets, and good governance.
At the same time, LBOs (leveraged buyouts) are taking place. Is that a concern in an emerging market? So far LBOs have been largely a developed market phenomenon. But India is now a large market, we have many large companies. These are issues that need to be addressed. There are no hard and ready answers at this stage. The IOSCO task force (of which India is a member) is looking into what we (regulators) need to do if at all there is anything to be done. The question is ‘do we need to do anything at all?’.
There are investors whose money goes into private equity funds. The securities market regulators’ task is to protect investors and if there is a category of investors who do not need protection, clearly our priority will be to guard those who need it. Few months down the line, there will be greater clarity on this issue (of regulating PE funds).
You have spoken about allowing hedge funds to invest in the Indian market directly. How do you plan to go about it?
Some funds have approached us saying, “We are hedge funds and we have very credible investors and there is a lock-in period for those investors.” Why are hedge funds feared? The traditional concern is that while hedge funds will bring in liquidity, they will also bring volatility as they have to perform better than everybody else. Their entry and exit are very quick compared with other funds, thus causing volatility. But some of these funds have told us that hedge funds are not one homogeneous category. There are some with a lock-in period for their investors.
Therefore, sudden investor redemption-led selling putting downward pressure on the market is unlikely in their case. These investors say the charge of volatility does not apply to them. “Look at who we are rather than grouping us in one large category called hedge funds,” they say. “In any event if we find India attractive, we are coming in through participatory notes,” they say.
Lock-in period for investors would reduce volatility to the extent that it is triggered only by unforeseen redemption pressures. But nothing rules out volatility. Today a retail investor can induce volatility by acting as a day trader. So, we thought of those category of funds that have a credible track record — with their top 10 investors being good, and are already present in the Indian market through P-Notes. Why not bring them in through a registration of their own. That is a possibility we are looking at.
Is there a conscious effort on the part of Sebi to phase out participatory notes?
I don’t think participatory notes will go away. It is not a tap that can be turned off one morning. What is the nature of the animal (P-Notes)? These are issued overseas to investors who are overseas. You are getting information on the basis of certification. There are no trades done in the market.
There is no STT (securities transaction tax). All these transactions are done outside the Indian exchanges. The intention of all markets over a period is that exchanges become the place where all trades take place. So if an entity is directly registered with us, all trades will take place through the exchange.
Our objective is to facilitate entry, except where there are concerns, and make participatory notes comparatively less attractive. You cannot wish them (P-Notes) away. They will disappear when the economy opens up completely and nobody needs to register anymore. But as long as there is restrictive access, those who do not find it attractive to invest directly, or are not eligible to do so, will invest through P-Notes. But over a period of time the proportion of investments through P-Notes will reduce.
Does not multi-layering of funds make it difficult for the regulator to curb instances of round tripping and money laundering? How is Sebi tackling these twin problems?
There are two sets of questions. One is can Sebi do it? Current regulations make it mandatory for the FII (issuing the P-Notes) to give a certfication to Sebi that he has the details of the entities to whom the P-Notes are issued. He provides the details to Sebi periodically. This should allay fears about the identity of the investors who are putting money into our stock market. If an FII gives the wrong certification, he may find himself out of the Indian market and that would be too high a price to pay.
If the concern is about round tripping — the tax escaped money from the country trying to find its way back — is it the securities market regulator that should look at it or is it some other regulator? We have other regulators within whose jurisdiction this falls (round tripping). Clearly, regulatory co-ordination is important to address this issue and that already exists in a large measure. The regulators in the financial services space regularly talk to each other, there is no issue at all on that front.
How serious is the issue of the Indian stock market being used as a conduit for financing terrorist activities?
All of this has its origin in a speech made by the National Security Advisor. The speech was not specific to India, it merely identified capital markets as one of the many sources for funding terrorist activities around the globe. We have KYC (know-your-client) norms in place. All the money that enters the securities market comes in through banking channels. There are no cash transactions. Now, banks have KYC norms. So they know which money is coming into the market.
Market intermediaries that bring people to the market, whether it is the broker or the DP, they also have KYC norms, they are supposed to know their clients. So whose is the money that comes into the market is supposed to be known. Now what seems to have been stated is that some people float companies, raise money in the market and use that money for terrorist activities.
Now, the application of the money made in the securities market is something that the securities market regulator cannot regulate and has not been asked to regulate. So money raised from the market being used for terrorism, or any other purpose, is beyond my regulatory turf and I cannot regulate it. That said, the issue of money from stock markets being used for terrorist activities is being hugely exaggerated. If it exists, it must be so minuscule as not to frighten us. And there are multiple regulatory bodies looking at it. I don’t think this is something that is to be unduly worried about.
So far Sebi has not passed any orders relating to insider trading? What has been the reason?
Insider trading exists in every market, it is not something that can be wished away. I am not saying it with any sense of satisfaction, but merely with a sense of realism. Markets operate on the asymmetry of information. If somebody takes advantage of information that is not in the public domain, we have to identify these, build iron clad cases and then take action against the entities involved.
We have a few cases in hand and I would not like to go into the specifics. Even if you look at a mature market like the US, recently the SEC has taken action against more than a dozen people from some of the very large intermediaries in a case that has been going on for years. It takes a lot of time to build up a solid case.
One way of reducing insider trading would be to reduce the asymmetry of information. Put as much information as is possible in the public domain, so that everybody who needs to know has access to that information. That is really the preventive side. On the punitive side, the task is to identify and punish, and I must confess that this is not an area where we have done extraordinary work, and this is clearly work in progress.
Companies often get away by making inadequate disclosures, especially denying developments though they eventually turn out to be true. Then there are also cases where the companies follow the disclosure norms in letter, but not in spirit. How do you plan to address this issue?
We have a regime of continuous disclosure, and companies have to disclose all material information to the stock exchange. Now who takes the call on what is material. Sometimes the company management may think that something is not material. It may turn out to be material. It is therefore for vigilant shareholders, for media, for stock exchanges and for Sebi to ensure that corrective action is taken. The other problem is the denials that come from the company. We don’t have a prescribed timeline as yet that says if a company denies something and that turns out to be true within x days..... we don’t have that yet. We are working on that.
The third problem, as much as I hate to say it, is the media. If you have two people from the same industry sitting together and having a cup of tea, you immediately sense that some day there could be a tie-up between those companies.... not tomorrow, not day after, maybe 1 or 2 years later.... you write a story with a few question marks, with sufficient hedges built in, so that should it happen a year or two years later, you can say that you were the first to spot it. That also puts pressure, and the companies come in to deny.
The key is really the market rewarding the companies that practice continuous disclosure and punishing those which don’t. If we (Sebi) had our way, we would like to incentivise the companies that practice continuous disclosure. For example when we introduced QIP (qualified institutional placements), we said that those companies which do not have a track record of continuous disclosures will not be allowed to take the QIP route.
Will the Sebi move to tighten disclosure norms for initial public offerings of real estate companies affect the launch of real estate mutual funds?
We have not said don’t come to the market. All we have said is that tell the market what you own and get it valued correctly. As far as real estate mutual funds are concerned, there are a couple of issues that are still being firmed up, we are working on the valuations and the accounting aspects.
Once these are sorted out, the product will be launched. We have been working on this, along with the members of the mutual fund industry and ICAI because there are some accounting issues involved as well. I am told that the valuations part is close to being addressed, it is the accounting part on which discussions are still going on.
Sharekhan Investor's Eye dated April 05, 2007
PULSE TRACK
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Inflation above market estimates
STOCK UPDATE
Orchid Chemicals & Pharmaceuticals
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs390
Current market price: Rs265
Orchid enters Canada
Key points
- Orchid Chemicals & Pharmaceuticals (Orchid) has received the approval from the Canadian Therapeutic Product Directorate for two of its abbreviated new drug submission (ANDS)—Cefoxitin and Ceftriaxone.
- These approvals mark Orchid's foray into the Canadian formulation market.
- Both Cefoxitin and Ceftriaxone are niche injectable products and have been generic for a couple of years. The size of the Canadian market for Cefoxitin is $5 million and that for Ceftriaxone is $30 million.
- As per company sources, Ceftriaxone has five competitors (Roche, Mayne Pharma, Sandoz, Nova Pharma and Pharmaceutical Partners of Canada Inc) while there is no generic competition for Cefoxitin.
- As per our back-of-the-envelop calculation, the product approval would add Rs0.4 per share to the FY2008 earnings.
- At the current market price of Rs265, Orchid is trading at 10.2x its FY2008E earnings. In view of the company's strong fundamentals and an improving balance sheet we remain positive on the stock and maintain our Buy call with a price target of Rs390.
Bharat Electronics
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,715
Current market price: Rs1,650
Exceeding expectations
Bharat Electronics (BEL) has announced its provisional results for FY2007. The gross sales have grown by 12% to Rs3,960.4 crore in FY2007, lower than our estimates of Rs4,191 crore. However, the improvement in its margins and a surge in the other income component have resulted in a relatively much higher growth of 21.8% in the profit before tax (PBT) to Rs1,041.6 crore (ahead of our estimates of Rs996 crore) during FY2007. This essentially implies that the PBT has shown a robust growth of 27.8% during the fourth quarter.
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WOW - Hotel Leela Ventures
Leela along with Kempinski a key move..
Hotel Leela Venture is the flagship of Leela groups. Leela is the well known chain of 5 Star hotels in India, catering to both business and leisure travelers. Hotel Leela Venture had a collaboration with Penta Hotels, UK, which was subsequently transferred to Kempinski Hotels, a European chain of 5-star deluxe hotels, owned by Lufthansa, the German airliner. The company has a marketing alliance with Kempinski for properties in India.
HLVL operates four hotels under the Brand Name of 'Leela' across India. The company has 1015 rooms in four major cities Mumbai, Bangalore, Goa and Kovallam (Kerala). All the properties are owned and operated by the Company. The Mumbai and Bangalore properties has a management tie up with Kempinski hotels. The company has entered into a marketing alliance with GHM (Aman Group) for its Goa property. The beach resort in Kovalam, Kerala was acquired in 2005.
Well placed in the Business and Leisure space and large expansion plans as well !
Leela's properties are concentrated in Mumbai, Bangalore, Kerala and Goa. The Brand name Leela is associated with them. The Leela Kempinski at Mumbai is centrally located near the International Airport with 413 luxurious rooms. Bangalore property, with lavish 376 rooms, is highly rated and contributes significantly to revenues. For the leisure travellers, Goa, one of the most visited tourist spots has 152 rooms. The Company acquired the Kerala property in 2005 which is a beach resort with 194 deluxe rooms with a panoramic view of the Kovalam shoreline.
HLVL enjoys highest room rates compared to its peers. Leela's hotel in Bangalore contributes 50% to the top line, followed by Mumbai and Goa. Bangalore has the highest occupancy rates and ARR ( Average Room Rent) compared to its other properties. Mumbai. and Goa continue to have a strong growth outlook in terms of ARR and occupancy. Bangalore ARRs have jumped significantly and are at record levels. Limited room inventory, high dependence on the Bangalore market and no presence in growth areas like Hyderabad, Cheenai, and Delhi are the negatives.
HLVL has an aggressive expansion drive for presence in key business and tourist destinations in India. The company has a capex plan of Rs 800 cr. The company has acquired land at Chennai to build 380 Rooms, Hyderabad with 300 rooms, Pune 260 Rooms, Udaipur 81 Rooms. The company also intens to set up an IT Park at Chennai (400,000 Sq Ft. ) and finally its in discussion for a management contract a hotel in Gurgaon Delhi with 419 rooms under a management Contract. The companies total rooms will expand by 1550 Rooms by the Year 2009-10. The Funds for this capex is raised through Internal Cash flows and from the stock issued at Rs 62.20 per share in September 2005.
Its in the investment phase for now !
India has emerged as the 2nd most rapidly growing tourism place in the world.. According to recent estimates of the WTTC, Indian tourism will grow at 8.8% (CAGR) over the next 9 years (from 06-15). Tourist arrivals are expected to touch new highs on the back of low cost airlines, growing infrastructure thrust by the government and India's emergence as an outsourcing hub. Addition to the room inventories over the next 2-3 years is not expected to be commensurate with this growth. It is likely that the demand will outpace supply in the short to medium term, and ARR's and OR's will see further growth during this period thereby driving industry profitability.
Leela's focus on luxury business hotels and its concentration on key metros like Bangalore and Mumbai has led the growth in ARRs and occupancies rate for the four consecutive year till FY06. However supply is expected to increase in Bangalore. This brings in a risk of slower ARR growth in FY07 and peaking in FY 08. Occupancies are expected to stagnate by 2009. Growth will come in from Leelas entry in Hyderabad , Chennai and Delhi (Gurgaon) ARR for the company for the year FY06 is at Rs 9778 and Occupancy rate seen at 78-81%.
The company is trading at a P/E of 22 for FY07E and 17 X for FY08 earnings. The big investments will happen in the next couple of years. Keep watch on this for now. Its not time yet to check in
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